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RS: I don't agree with that. I think you said in some correspondence we had, "find me an economy where a 10 per cent boost to real, broad money in six months has not boosted asset prices, demand etc" — in other words, talking about demand. The explanation lies in what happened to velocity. It was the fall in the velocity of circulation — of the demand for, and supply of, loans — which produced the initial fall in the money supply. There was a loss of confidence, banks stopped lending, companies stopped borrowing. And the recovery now depends on banks lending more and people spending and borrowing more, not on a simple increase in Bank money. In the long run, I agree that there is a stable relationship between the quantity of money and the
velocity of circulation, but in the long run, as Keynes famously said, we are all dead.   

TC: There is a problem with the money numbers at the moment in the UK. Three or four years ago, banks were creating semi-bank subsidiaries, to bypass capital rules. Deposits have been held in those subsidiaries, and they have been doing all sorts of very odd things in the last year or two. Because of that, the Bank of England has correctly taken out these semi-bank deposits from the measure of money they and other economists look at. This measure is called M4x, with the "x" denoting that they've excluded these semi-bank deposits.  

And the relationship between that M4x measure and what's happened to demand in the economy shows that this was the driving force behind this cyclical episode, as it was behind the cyclical episode in the late 1980s, the boom-bust then, and the boom-bust in the early 1970s and mid '70s, both of which I've written about at some length. If you're running a business, how much money you have in the bank is critical. And if all the businesses in the country find that their cash balance — the amount of money they have in the bank — is being squeezed, then you will get a thumping great big recession. And I'm afraid the latest episode is dramatic confirmation of the relevance of money to macroeconomic outcomes. To end the recession you need more money in the economy: that is the critical point.

RS: Of course you need more money in the economy. It's the relationship between money and the real economy that is crucial. I would agree — banks have to lend more, and it's also the case that people have to want to borrow more, and that depends on companies' profit expectations. What I think you're missing from the whole thing is the issue of psychology and confidence. 

Let me go back to a point that you made earlier, which is that fiscal policy is irrelevant. Certainly, the amount of discretionary fiscal stimulus has been quite small so far, though more is coming on. But that excludes the automatic stabilisers. In fact the government has been running a very large fiscal deficit. Despite this huge injection of money into the banking system, Mervyn King himself said: "The recovery hasn't happened." If this is the best that monetary policy can do, we certainly need fiscal policy as well.

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Ralph Mugrave
October 23rd, 2010
11:10 AM
In your flax economy you say that printing money destroys “the value of the participants' cash balances”. So how come the monetary base of the U.S. increased by an astronomic and unprecedented amount 18 months ago, yet inflation is currently at record lows? As distinct from the above evidence, and moving on to the INTENTION behind money printing, the intention or objective is to bring sufficient extra demand to bring full employment, but not so much as to cause excess inflation. Also in your flax economy you make the very unrealistic assumption that there is only one final product, namely clothing, and that the market for this is saturated. But let’s run with that assumption. An economy where there are no consumers who want any more goods or services is an economy where there is no unemployment. That is there is no one who wants to work extra hours so as to consume more. No Keynsian with any common sense would advocate money printing (or any other method of increasing demand) in these circumstances.

Richard Allan
March 29th, 2010
11:03 PM
I'm an economics graduate from the LSE, and I don't understand why this article concentrates on those parts of "macroeconomics" which we only teach to first-year students, and abandon in embarassment by the end of even a three-year Bachelor's degree. The ideas being discussed in this article have absolutely no currency with the economists that I've known. The idea that printing money, or increasing consumption, can somehow increase wealth is ludicrous. Anyone constructing a theoretical economy in his head should be able to see this for himself. Printing money will discourage people from holding cash balances; this will INCREASE instability in the economy by leaving people more vulnerable to liquidity demands. Increasing consumption can only destroy accumulated wealth all the faster. Let's say we have an economy where one worker grows food, another flax, and a third weaves flax into linen. They each "hoard" cash in expectation of future spending requirements. Now suddenly the demand for linen and therefore flax drops off; perhaps the market for clothing has become saturated. What's the commonsense response? Telling the two textile workers to find new jobs. But this would cause "excess capacity" in the economy (the land would have to be ploughed under before it could grow anything else, and the sewing machines are worthless) and "unemployment", which Keynesians can't allow. So what's their solution? Print money, destroying the value of the participants' cash balances, and use it to "stimulate the demand" for textiles, presumably by buying the stuff up and burning it (as we all know occurred during the New Deal). This allows the textile workers to keep their jobs! But what happens to savers? Well, either they have to shrug their shoulders and eliminate their "real savings", leaving them vulnerable to "liquidity shocks" (like a sudden bout of illness rendering them unable to work), or they switch their cash savings for, well, REAL savings; ie. stored food. But assuming the economy is producing the maximum amount of food possible (at least until the flax land is repurposed, which we've decided to prevent for the sake of the textile industry), increasing the amount of "hoarded" food is surely worse for food consumption than any amount of "hoarded" cash. At least someone was eating the damn stuff beforehand! So if the farmer decides to stop saving, and is then laid low by illness, there will be a very sudden "panic" in the economy as textile workers scramble for food production. But if workers replace their cash savings with food savings, inflation won't work any more! You can't print food with which to buy clothes; and since the farmer doesn't want to trade food for clothes (he has enough already), and doesn't want to hold cash (loses its value too quickly), we'll end up with the textile industry collapsing either way! The only difference is that in the meantime, we forced people to make an undesired switch from cash savings to either "no savings" (more volatility in the economy as a result of unpredictable expenditures) or "real savings" (reducing the supply of real goods for consumption). The "fiscal" alternative is a similar Devil's bargain. Either take the farmer's food in taxes now, or borrow food from him, promising to tax him later to pay back his own debt (Ricardian Equivalence shows that these two are exactly similar in terms of effects). If the taxes cause him to scale back his production of food, then you've reduced real wealth in the economy. But if they don't, then surely the taxable proceeds would be better invested somewhere else than in a failing line of business? The same can be said if inflation somehow doesn't cause anyone to alter his cash balances; the concept of opportunity cost means that wasting money (and goods!) by putting them to bad use is just as bad as destroying them. The only way that printing money can increase wealth is if there is genuinely idle capital in the economy which could be devoted to the production of real value (ie. happiness), but for whatever reason, is not. However, the only plausible mechanism by which this capital could be put to work by printing money is if wages are "sticky downwards", so the workers are effectively refusing to work for a utility-maximising wage. But firstly, printing money to force down their real wages was a stupid idea in Keynes's time (where index-linked wage contracts were already becoming commonplace) and is an even more stupid idea nowadays. It will just not have the desired effect. And secondly, if workers refuse to work for a utility-maximising wage, this must be regarded as a voluntary decision on their part; and as a believer in the Harm Principle, I don't believe it's the government's role to reverse voluntary decisions (or "indecisions"). And thirdly, I find it far more likely that diverting any funds to government will be used to reward unproductive special interests than to match genuine demand with genuine excess capacity. In conclusion, I find that this entire article is based on a vision of economics that is (i) out of favour with the economics establishment, (ii) easily disprovable by thought-experiment to anyone capable of consecutive thought, and (iii) a mere attempt to justify government intervention in the economy for its own sake, and for the sake of increasing the "mystique" surrounding economics in order to justify an increase in economists' salaries. The fact that it has attracted no comments thus far is evidence that it has been treated by the readers with the confusion and indifference that it deserves; I simply couldn't allow it to go unchallenged myself.

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